Commercial Real Estate Recovery

The commercial real estate market is showing signs of recovery, but the path forward may be a bit uneven.

Key Takeaways:

• The Federal Reserve began cutting interest rates last month for the first time since 2020, dropping them by 50 basis points and signaling more cuts could be on the way.
• This policy shift is seen as a positive sign for the commercial real estate (CRE) market, as lower rates can boost refinancing and sales activity.
• Sales volumes are already increasing, especially in the multifamily sector, while some sectors like office space continue to face challenges.

The Fed's Shift and Its Impact

In September, the Federal Reserve lowered interest rates for the first time in years, cutting the Fed funds rate by 50 basis points. This is big news for commercial real estate, a sector that thrives on affordable financing. Cheaper debt could help jumpstart deal-making, which had stalled in recent years due to higher borrowing costs and economic uncertainty.

The Fed's change in policy is viewed by Wells Fargo analysts as the most promising sign yet for a commercial real estate rebound. While lower rates aren’t a cure-all, they set the stage for recovery by making borrowing easier and boosting investor confidence.

Refinancing and Sales on the Rise

After a slowdown in transactions over the past few years, the tide is beginning to turn. According to Walker & Dunlop CEO Willy Walker, refinancing and sales volumes are picking up as the market feels more optimistic. In fact, transaction volumes saw their first quarterly increase since 2022 during the second quarter of 2024, driven by strong performance in the multifamily sector.

The second quarter saw over $40 billion in commercial real estate transactions—a 13.9% increase compared to the previous quarter. Although this number is still lower than last year, the upward trend suggests momentum is building. Property valuations are also showing signs of improvement, with the MSCI U.S. REIT Index climbing steadily since the spring.

Office Sector Still Facing Challenges

While some parts of the CRE market are bouncing back, the office sector continues to face headwinds. Despite modest improvement in net absorption (the amount of office space being occupied) for the first time since 2022, vacancies continue to rise. Hybrid work models and sluggish demand are keeping vacancy rates high, particularly in major cities like Manhattan.

Prices for office buildings in central business districts remain well below pre-pandemic levels, with some areas seeing declines of nearly 50%. Experts like Chad Littell from CoStar Group note that the office market may take another year or more to stabilize fully.

Multifamily Sector Gaining Strength

On the flip side, the multifamily sector is experiencing an uptick in demand. Net absorption reached its highest level in nearly three years during the second quarter, even as a record number of new rental units are being completed. With single-family homes becoming less affordable, many households are opting for rental properties instead, driving demand for apartments.

Rent growth may have slowed from its double-digit peak in 2021, but multifamily vacancy rates have stabilized, holding steady at 7.8%. This healthier balance between supply and demand signals a bright outlook for the sector, with high homeownership costs continuing to support strong rental demand.

Looking Ahead

While the recovery in commercial real estate is promising, it won’t be the same for every sector. Multifamily is leading the charge, but office spaces may take longer to bounce back. As interest rates continue to drop, the overall market could see more activity and stabilization, but the pace of recovery will vary. Keep an eye on interest rates, inventory levels, and market trends as we move into 2025.

Original article: Commercial real estate recovery may be uneven